LNG Floods Europe, U.S. Cargo Cancellations Possible

Even a limited number of cargo cancellations would mark an extraordinary turnaround from a tight market that’s been shaped by supply fears since Russia invaded Ukraine. It would also come just ahead of what’s likely to be a bullish winter driven once again by Europe’s arduous task of getting through another heating season without Russian imports.

U.S. offtakers “canceling LNG exports again this year is not in our base case, and we don’t see it as likely,” said Goldman Sachs’ Samantha Dart, head of natural gas research. “But if you ask me whether there’s a scenario where that happens, the answer is yes.”

Dart told NGI that the U.S. export arb could shut if Europe injects about 1.5 Bcf/d more than the firm’s projected rate of 3.8 Bcf/d between April and October. In that case, she said Europe wouldn’t be able to balance with coal-to-gas switching or even by redirecting liquefied natural gas cargoes.

If Norway, which boosted production and completed heavy maintenance last year, did not respond in that scenario, Dart said “U.S. LNG cancellations would be the only way out, in our view.”

“You can definitely create scenarios where Europe gets really weak and the U.S. gets strong, or strong enough, that on a short-term basis, the numbers look negative,” he told NGI. “There’s definitely a scenario where that could happen for sure.” 

Joseph added that there’s a “huge number of variables” clouding the LNG market outlook in 2023.

European storage is at the highest level in over a decade for this time of year. Buyers scrambled to secure alternative supplies last year after Russia cut off most gas deliveries, while a mild winter helped preserve stocks. European Union (EU) natural gas inventories are currently at 56% of capacity, compared to the five-year average of 35%.

The last time Europe’s natural gas storage was close to current levels was in 2020. The Covid-19 pandemic significantly curbed global energy demand that year and left storage on the continent to act as a sink for excess LNG supplies. It’s estimated that up to 200 U.S. cargoes were canceled in 2020. At the time, Asian and European gas benchmarks sank to parity with Henry Hub prices in the United States, which made it unprofitable to move cargoes overseas.

European natural gas storage injections have tended to start falling off around June or July during similarly bountiful periods. Current gas market dynamics would likely guarantee cargo cancellations in any other year, said Brad Hitch, a former LNG trader and special NGI contributor.

The call for LNG in Europe might not weaken given the continent’s need to replace Russian supplies and a host of other factors the market is monitoring.

If the U.S. is forced to shut-in some LNG production later in the summer, then it would likely be because of Northwest Europe’s inability to absorb the super-chilled fuel, Hitch said.

“You would expect it to price out in a way. They wouldn’t be able to take the LNG in because they wouldn’t have a place to stick it,” said Hitch, a former vice president of portfolio management at Cheniere Energy Inc. “And the only way to stop the LNG from coming in is dropping the price to a certain point where it stops coming. If the LNG doesn’t have anywhere else to go, it’s not going to produce out of the U.S.”

According to Joseph’s calculations, European gas injections would only have to be at roughly 70% of the normal rate to fill by Nov. 1. If gas is injected into storage at rates similar to last year, inventories would be full by the first week of August, he said.

Morgan Stanley analysts made a similar projection in a note to clients last week. They said stockpiles could also be 100% full by late August if demand remains weak and LNG continues to flood Europe.

The Wildcard

The United States is Europe’s largest source of LNG. It accounted for nearly 42% of the continent’s supplies last year and has provided roughly the same volumes this year, according to Kpler data. U.S. LNG production continues to operate at or near capacity, particularly as the Freeport LNG terminal has ramped back up following an explosion that knocked it offline last year.

Kpler analyst Ryhana Rasidi told NGI that the firm expects U.S. LNG output to grow by 10.3 million tons year-over-year in 2023.

Asian demand remains a big wildcard for the market this year as storage inventories are said to be at or near tank top. The region will need to restock for winter, and Europe could ultimately burn more gas if prices fall further. Both factors could help to offset the expected loss of injection demand in Europe and bring cargoes back into play that might otherwise not be needed.

But demand trends have been weak, even adjusting for mild weather, Morgan Stanley said.

“Asian consumption is still trending below what is needed to absorb surplus cargoes from new capacity, namely the Freeport restart, and an eventual slowdown in EU imports, which our team believes is needed to prevent overfilling storage,” Morgan Stanley analysts led by Devin McDermott said in a note last month.

In Asia, the outlook for China is mixed. Larger buyers remain on the sidelines despite a projected rebound in spot buying as the economy continues to recover from the pandemic.

Morgan Stanely also noted last month that nuclear reactors returning to service in Japan and South Korea could limit LNG imports in those countries this summer. And while some price-sensitive buyers have returned to the market, others like Pakistan have outlined plans to limit gas purchases and boost coal-fired power instead.

“There is no demand so to speak of right now,” said Trident LNG’s Toby Copson, global head of trading. There are no “current demand drivers” in Asia, Copson told NGI.

Until that changes – which he said for now doesn’t appear likely even after shoulder season ends –  Copson expects LNG in Asia to be range bound at values between $11-$13/MMBtu.

Morgan Stanley also expects Latin American demand to remain flat this year, driven largely by Brazil, where hydropower reservoirs remain high.

Demand Response

With supply set to outpace demand, Morgan Stanley said prices would need to continue falling to levels that incentivize more consumption.

Prices have fallen precipitously since record highs last August, when the Title Transfer Facility (TTF) in Europe traded at about $100/MMBtu and the Japan-Korea Marker traded near $70/MMBtu. Both contracts are currently trading well below $20, and are roughly half of their value at the beginning of the year.

Despite the steep declines, Rasidi pointed out that while some gas-intensive plants in Europe have been restarting, natural gas prices on the continent are still roughly double where they usually are at this time of year. “As a result, we would probably not see industrial demand returning to pre-invasion levels,” she said.

Energy Aspects’ James Waddell, head of European gas and global LNG, added that some industrial demand is unlikely to return at all on the continent given that some companies relocated their operations to take advantage of cheaper gas supplies in places like the Middle East and North America.

For other businesses, he said, lower prices have to be sustained over a longer period before restarting operations or switching back to natural gas.

“Because their supply is often coming from aggregators who pass through wholesale costs with a lag, it does take time for the drop in wholesale prices to be passed through to industry,” Waddell told NGI.

Energy Aspects does expect European gas demand to recover this year to levels last seen before the war in Ukraine.

Indeed, Goldman Sachs analysts led by Dart said late last month that the longer TTF remains low, the stronger demand will be. That could tighten the market as summer ends. Goldman expects TTF prices above $30/MMBtu by then, which is also likely to lift forward winter prices, setting up for a bullish stretch.

“If you look at Europe’s demand profile, it has always been a very heavy seasonal heating market,” Hitch said. “You can be completely awash with gas in August and have nowhere for it to go, but it really doesn’t matter because if you have two or three weeks of cold that can really wipe out your storage. No matter what happens this summer, there should still be a pretty heavy risk premium on the winter.”

Government officials across the EU have repeatedly warned of the need to maintain vigilance and conserve natural gas supplies regardless of the surplus in storage. The bloc also recently extended voluntary natural gas consumption cuts until next year.

If prices do tick back up toward the end of summer that could ultimately limit demand, ensure LNG continues flowing into Europe and keep storage stocked.

“No matter how early inventories are built, Europe in the winter still balances on incremental imports and that means you have to bid the LNG at a high enough level that it doesn’t go to other markets,” Joseph said. “So, you do end up with basically the same dilemma in terms of supply security going forward.”